Firms also hedgerinsure individual short-term transactions with currency derivatives. But in doing so, they do not appear to rely on an aggregate measure of
their transaction exposure. Overall, the hedging approach we infer from the data is puzzling. Taking into
Ž account the RP of firm value or at least that of cash flow or of transaction
. exposure could help firms better calibrate their on-balance-sheet hedges and take
advantage of currency derivatives. The balance of the paper is organized as follows. Section 2 clarifies the
terminology. Section 3 discusses the structure of the questionnaire used in the survey. Section 4 describes the sample of firms surveyed and provides information
about response rates and associated descriptive statistics. Section 5 documents the finding that industrial firms do not know the currency RP of cash flow or the
currency RP of firm value. Section 6 discusses possible reasons. Section 7 documents the on-balance-sheet hedging activities and provides an explanation of
why, under this hedging approach, industrials do not quantify their currency risk exposure. Section 8 debates the findings’ applicability to other countries. Section 9
examines whether the information obtained in our survey can be considered accurate, and Section 10 draws conclusions.
2. Terminology
There are many ways in which firms can protect against foreign exchange risk. Ž
. Bodie and Merton 2000 list four broad possibilities. We use their taxonomy.
First, firms can simply avoid risk. That would seem to involve choosing to sell or buy in markets that are not exposed to currency risk. In an open economy, this is
almost impossible to achieve since even if firms are able to avoid direct exposure, at least some of their suppliers, customers, or competitors will bear some
exposure. Second, firms can reduce the likelihood or the severity of losses. A Swiss company that exports to France can finance some of its operations with
French francs or buy materials from French suppliers.
Third, firms can transfer risk to others. There are basically three ways they can do this.
v
They can hedge. That means that they can sell potential gains from favorable currency changes to cover losses from unfavorable changes. A Swiss importer, for
instance, can enter into a forward contract to buy Italian lire to fund its purchases from its Italian supplier.
v
They can insure. This involves paying another party to assume their currency risk. For example, some firms insure with currency options, whereas others do so
by invoicing in Swiss francs rather than in foreign currencies.
v
They can diversify. An importer can source from suppliers in different countries rather than from only one supplier. This diversification spreads risk over
different, possibly uncorrelated currencies. The suppliers assume some of the
importer’s risk since, all else being the same, the importer will buy from the suppliers with the more favorable currency rates.
Ž .
The final approach to risk protection in the Bodie and Merton 2000 classifica- tion is risk-bearing. Firms can simply decide that the risk they are exposed to is
too small to worry about.
3. Survey characteristics
The questionnaire consists of 44 questions grouped in nine sections.
4
No question is open-ended, meaning that firms are asked to check from a fixed set of
Ž .
Ž possible answers the one or the ones they agree with they are always given the
option, however, of formulating their own answer if the ones we offer do not .
apply . The questionnaire was sent to the firm’s chief financial officer or, if there was no such function, to the controller or the treasurer. The implicit assumption
was that these are the persons most likely to have the relevant information. The survey is structured as follows.
Part 1 is an icebreaker. It asks whether the firm has hedged in the past, what Ž
currencies it has hedged, and what parties shareholders, creditors and financial .
analysts, among others are told what the firm does to reduce currency risk. Part 2 investigates contractual clauses, money market hedges, and operating
Ž .
adjustments e.g., changes in credit policy and product lines, outsourcing that the firm can use to protect against currency risk.
Part 3 examines frequency of use and type of currency derivatives employed and assesses who in the firm has the authority to trade currency derivatives. Part 4
inquires how much exposure companies hedge and the role played by expectations in making that decision. Part 5 asks why companies hedge against currency risk.
Part 6 surveys the variables that companies want to protect against currency risk Ž
. operating cash flow, taxable income, firm value, and liquidity, among others and
the time horizon of relevance in hedging operations. Part 7 tests for the qualitative and quantitative impact of unexpected currency
swings on the operating cash flow of the firm. Part 8 assesses how currency volatility affects firms. Part 9 includes questions designed to establish the identity
of the person who fills out the questionnaire, assess the validity of the answers, and clarify possible misunderstandings.
4. Sample construction and descriptive statistics
